The Only Airline Stock Worth Owning in 2011

Alaska Air Group has something that every other U.S. airline covets, and we are not even talking about the hub in Seattle, the closest major U.S. city to Northern Asia.

Rather, the airline's crown jewel, for the moment, is the performance of its stock. So far this year, Alaska is the only major airline to show a share price gain for the full year. This is not a matter of a few percentage points. Through Wednesday's close, Alaska shares were up 13 percent year-to-date.

Next best is United Continental, down 16 percent, followed by Delta and Hawaiian, both down 32 percent.

Spirit Airlines has also done well, rising 26 percent since going public in May at $12 a share, but it's traded for only five months.

Sell-side analysts spotted Alaska many months ago, and it's been a Wall Street darling throughout the year. A Feb. 7, 2011 story in TheStreet was entitled "Why Wall Street Loves Alaska Airlines." It quoted from a report called "Believe It Or Not, An Airline That Earned Its Cost of Capital; Bravo!" by CRT Capital Group analyst Mike Derchin.

At the time, Alaska's stock was trading at $61.65. The shares closed Wednesday at $65.54. During the same period, the S&P 500 is down 5 percent.

The third quarter was Alaska's best quarter ever, with net income excluding items of $131.1 million or $3.58 a share, besting estimates of $3.33 a share. Alaska's earnings call last week was a bit of a love fest, and analyst comments afterwards were broadly positive.

Derchin, for instance, wrote that "the airline industry has a 'how to' blueprint to navigate successfully through turbulent times. It is called Alaska Air Group. Management has transformed this former intra-state regional airline into an industry paragon."

"By capitalizing on its strong consumer niche in the Pacific Northwest, Alaska has built a profitable East/West network, stretching from Honolulu to Newark, to complement its historic North/South operation, extending from Anchorage to Acapulco," Derchin continued. He set a price target of $110.

Meanwhile, Ticonderoga Securities analyst Jim Higgins set a price target of $84, saying, "We remain impressed by the strength of Alaska's strategic position and painstaking tactical and strategic execution. If we could own only one airline stock it would be Alaska."

On the quarterly conference call, CFO Brandon Pedersen noted that "Our trailing 12-month return on invested capital stands at 12 percent and it appears very likely that we will exceed our 10 percent after-tax ROIC goal for the second consecutive year," while Alaska Air president Brad Tilden said the 17.7 percent mainline pretax margin "will once again be among the best in the industry."

On the negative side, Alaska, like Southwest, suffered fuel hedging mark-to-market losses which amounted to $84 million in its latest quarter. Additionally, pension expenses are likely to increase from about $42 million in 2011 to about $67 million in 2012. Pension costs are "a big headwind we are facing next year," Pederson said.

In February interviews with TheStreet, Pedersen said that generating a 10 percent return on invested capital has been a longtime goal that the company finally beat in 2010, while CEO Bill Ayer said "We've been working on achieving this return on investment capital goal since 2003." The underlying story here is that is that Alaska unveiled a restructuring plan, which included fleet renewal and cost reductions, in 2003, and has stuck with it.

During last week's call, analysts sought to discern Alaska's secret for success, which — in addition to keeping costs low — appeared to consist largely of successful route selection combined with a willingness to quickly drop routes that don't work.

Alaska said it plans to grow about 5 percent next year, primarily by adding capacity into Hawaii and in regional markets such as Seattle to Spokane, Boise and Kansas City (Southwest will drop Seattle-Spokane service in January). Over the past four years, Alaska has redeployed 21 aircraft from existing West Coast markets to new markets, mainly in Hawaii but also mid-continent and trans-continental flights. "We have increased our profit margins in every one of our 12 regions," Tilden said.

On the Seattle-Kansas City route, which will begin in March, 2012, "the demand is about 95% of Seattle-Saint Louis and Seattle-Austin, and we know how we do there," said Andrew Harrison, vice president, planning and revenue management, during the earnings call. "We have low airport costs and we fly there and back in a day," so overnight costs for crew hotels are avoided.

"We've had a focus on Seattle, on going more places out of Seattle," Harrison said. "We have become a more important carrier, from a network utility standpoint, for folks that live in the Pacific Northwest."

Harrison added that the airline reviews routes each month and is small enough that CEO Ayers is familiar with the performance of every route.